The market giveth, and taketh away. That’s how quick sentiment can change in today’s market. Last Tuesday’s drop, credited to the inflation data being hotter than anticipated, is a sign that the economic problems we have now, will likely last for longer than we originally anticipated.
The market (in its infinite wisdom) is grappling with the prospect of a Fed that will hike us into a major recession. It’s easy to believe this given the Fed Chair’s comments, which I believe are scare tactics, designed to scare us all into reducing our spending, thus slowing inflation. No matter what the Chairman says, the committee will review the data and if inflation is still running too hot, they will continue to hike, if the data shows signs of a reduction of inflation they will either slow down the speed of hikes or stop them all together.
If you read some market commentators, they are looking for a rate cut in 2024, thinking the Fed will overshoot. They may well be right. But either way it doesn’t matter. Just like trying to pick which way the market is going to go on a daily basis, trying to predict economic data, even if you’re right – may still lead to a wrong investing decision.
Now is the time for the Discipline part of investing. I preach investing isn’t rocket science, it’s a process and a discipline. It’s easy to stay disciplined when the market continues to rally for no particular reason, it’s tough when it’s in free fall. Even tougher when we’re not used to it. The two charts below show the percentage dropped from all time highs. First one is the last 12 months, and the 2nd one is the last 10 years. Aside from Covid, which was a quick whack, followed by a quick recovery, we haven’t had a “Bear Market” (classified by a 20% drop from all-time highs), for about 14 years. We’ve grown accustomed to waking up and hitting another all time high. That has likely changed for a little while.
Here’s a few things I want to put in front of you as our discipline is tested:
- High inflation is bad, but deflation is worse. The economy needs to grow each year, and ideally in a Goldilocks type of way. (Not too hot, not too cold, but juuuust right). If we had no inflation, why would you invest at all? Or why would you borrow money for a house etc.? Companies raise prices to maintain their margins (more about that below), and borrowers lock in an interest rate/payment today, knowing that their wages are likely to increase in the future, thus making it easier to maintain those payments. Some level of inflation is crucial for an economy to thrive.
- By the time the data is peaking (which in my opinion it already has), the market has usually already rallied. It’s easy to see evidence from that the June 17 low, that was set. From June 17 to August 16, we witnessed a 17% rise in the index. Since then, we have given up about 8% of that. This coincides very closely with earnings. The majority of companies in the S&P 500 report their earnings in the time period of a week or two after the end of the quarter and is about 4 weeks in duration. I believe we will see something very similar again this time around, so, I’m looking to be positioned for some good news for earnings from mid-October for a 4-week period. This rolls into elections, with the odds firmly in the camp of political gridlock. With the market being a forward predictor, it would not surprise me to see it generate some steam before earnings are announced.
- Last but not least for this week’s points. Companies are way better at dealing with inflation than anyone gives them credit. The market always comes back to earnings, and I believe the thesis of an organization is to return value to shareholders. In periods of inflation, where companies are paying more for the goods they provide, the question is how well are they able to pass those costs through to the consumer? That’s what keeps them in the game. The graph below published by Fisher shows just how well companies have done in improving profit margins during this time of inflation.
From a technical standpoint, the market has been able to maintain an important support level. The Fibonacci retracement level of 61.8% held up through this recent couple of pullbacks. Don’t worry about the name, it’s just some Italian guy that developed the percentages based on lots of previous data. Take from it that historically when these levels hold, it’s turned out to be buying opportunities.
So, with all that, we have a Fed meeting this week on the 20th-21st. That’s when Powell gets in front of the media and pummels the market, so I expect some volatility from that, and that may be the opportunity I’m looking for to lift my enthusiasm. Keep the discipline…
Here’s the Buy/Sell.
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